The growth in the use of contractors, especially in the IT industry of the late 1990s in the UK, was the cause of the rise in them using companies for tax planning purposes. The types of companies used by contractors were different, as they were usually performing the work of a single client.
The HMRC brought IR35 legislation into effect in 2000, to be able to effectively tax such contractors.
Contractors thereby started creating two types of companies to prevent themselves falling under IR35 legislation, namely Personal Service Companies (PSCs) and Managed Service Companies (MSCs). A personal service company (PSC) is owned and operated by the same person, in many cases the same shareholder and director. A managed service company (MSC) is a company where the shareholders and directors are also the workers in the company. In almost all cases, PSCs and MSCs normally do all their work in a financial year for a single client.
More recent IR35 legislation after 6 April 2021 has significantly reduced the criteria which enable companies to operate as PSCs or MSCs. If they cannot operate that way, they are supposed to go under IR35. The only other way to avoid IR35 classification is to operate under an umbrella company. If one still operates under a service company and HMRC decides later it was not to have done so, it may have be liable to backdated tax and a fine.
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